Monday, August 16, 2010

The stock market sold off 3.5% last week for no particular reason. This probably reflects the dog days of summer and the light trading volume that is going on. If professional traders made the concentrated effort to move the market lower, it is relatively easy to do when there is low volume.

The reported reason for this sell off was the lack of action by the Federal Reserve System. This is one of the most quoted but misunderstood government agencies. The Federal Reserve System only has two stated goals as stated by the legislation that created it: to encourage full employment and maintain price stability. It is not the Fed's specific job responsibility to encourage the economy. Even with the slowdown in GDP in recent quarters, they are doing an excellent job at maintaining price stability.

There's a lot of talk in the press right now regarding the GDP, which was previously announced at 2.7%. Since imports greatly exceeded exports for the month of June, most learned economists forecasted that the GDP's previous 2.7% announcement would be cut to around 1.5%. Even at 1.5%, the economy continues to grow, and that's not a negative matter. However, it's important that you understand the effect of imports exceeding exports for the second quarter.

Since GDP is determined by "gross domestic activity," is doesn't have any effect on goods manufactured outside the United States. This so-called negative is interesting because many goods manufactured outside the U.S. are actually manufactured by U.S. companies. A significant portion of the Chinese imports are produced by companies that are somewhat U.S.-owned. Therefore, the real effect of this reduction in GDP is to take out GDP from the second quarter of 2010 and flip it into the third quarter. Even though economically nothing has really happened, if the first quarter GDP is downgraded when the imports are actually sold to the 1.5% range, I project that third quarter GDP will be 3% or greater. You'll see a lot of press on this subject, but it doesn't mean a whole lot economically.

Last week's stock market sell off was supposedly based on the Fed's announcement that they would use their excess money from the retirement of assets to acquire Treasury bills. Quite frankly, that is not news at all. For some time, the Fed has been in a quasi-tightening mode by taking money out of the Federal Reserve System and accumulating it on its own balance sheet. Anytime the Federal Reserve uses their excess cash to acquire assets that is an easing technique.

Envision a bank that holds particular assets that the Fed buys them, then the bank has excess cash it must loan. That improves the economy by putting more cash in the system for the banks to make business loans. Therefore, the Fed's announcement that they would be using their excess cash to buy Treasury bonds essentially indicated that they were no longer in a tightening mode. Frankly, the Fed doing that is a good thing, and the sell off of the stock market was because they just didn't understand the moves.

I have a client that often sends me strange stories that represent the weird part of our population. Almost always, they come with the anecdote, "You Can't Just Make Up This Stuff!" The more I read about Congress and the bills they've passed to supposedly help the economy, I come to the same conclusion -- you just can't make up such weird stories.

Recently Congress was called back into session after they recessed for summer vacation in order to pass an emergency $27 billion appropriation to fund teacher salaries across the United States. While this sounds honorable, it is almost laughable when you research what they were actually doing.

First and foremost, teacher salaries are a local function. In fact, education is a state function, not a federal function. Education in the U.S. has always been local -- that is the way it should be. While it's true that the federal government provides grants and other enticements for local school systems, the management of school systems is solely a function of state governments. That fact makes this appropriation even weirder.

Congress has developed a conscience as of late. I hope it's not too late, but I hope they've decided that for every new outrageous spending bill they pass, they must find an offset so that the net cost to the budget is neutral. I certainly wish they would've thought of that concept about $3 trillion ago.

Anyway, the $27 billion appropriation was designed to prevent teachers from being laid off and supplement teacher salaries. No one would question that this is an honorable goal. However, the way it was paid for certainly raises concerns. In order to pay for this particular bill, Congress withdrew $14 billion from the food stamp program and added some reduction of foreign tax credits for corporations to offset the costs.

It's easy to see that this does nothing to stimulate the economy. While the people retaining their teaching jobs would have money to improve the economy by additional spending, it would be almost universally offset by the reduction of food stamp program, which would reduce the amount of money spent in the economy by poor people. Hardly seems to be a fair offset.

In addition, it should be clear to everyone that these do not create lasting jobs. While you can supplement a teacher's salary for a short period of time with this federal budget allocation, it will not create lasting jobs and therefore, only is a short-term stimulus that probably does more harm than good. Who pays that salary next year? It doesn't even address the issue as to what the local school systems are going to do about their cost structure.

Perhaps its time that some of these teachers do go away and costs be cut in other areas of the school system. The fact that the school systems cannot raise property taxes doesn't prevent them from being frugal in their operations since they can go to the federal government and cover up waste and abuse of funds by having the government subsidy. Any federal reimbursement of state expenses only "kicks the can down the road" since it does nothing to address the issue of local funding of education and forcing the states to deal with their own internal problems.

I just wonder how you as a taxpayer feel about funding the abuse that is going on in California and their budget deficits that are approaching $5 billion per year. I think it's perfectly reasonable that taxpayers in Georgia are funding the state of California (not!), which has demonstrated that they have neither the capacity nor desire to even come close to funding their own budget deficits.

I don't like to think of myself as a conspiracy theorist, but I am concerned that they are passing such a bill 12 weeks from the mid-term election (which will replace one-third of all U.S. Senators and the entire House of Representatives). Isn't it interesting that we took money away from poor people and gave it to a teacher's union which openly advocates and supports only one political party? I don't want to think that taxpayer money would be used to buy votes, but it's hard to argue in this particular case that it was in the country's best interest to subsidize these teacher salaries. Perhaps it is in the best interest of a political party representing one-half of the U.S. population.

Thirty year mortgages today hit 4.5%. You can get a 15 year mortgage for 4%. By using Freddie Mac or Fannie Mae, you can receive the lowest long-term mortgage rates ever seen in the United States.

What is ironic about his particular matter is that all of these government agencies are now losing in the aggregate roughly $3 billion a quarter. Do you have any concern about paying in taxes to subsidize a governmental agency so some people in American can get lower interest rates? I particularly have this concern for those who have no mortgage whatsoever. Do you think it's reasonable and fair that you are paying higher taxes in order to subsidize Freddie and Fannie so that they can give a lower interest to your neighbor. I don't want to be an alarmist, but maybe you should think about these matters.

As always, the foregoing are my opinions, assumptions and forecasts. It is perfectly possible that I am wrong.

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